Non-competes – The Beginning Of The End?
Non-competes – The Beginning Of The End?
Background
For many decades, the extent to which a UK employer can prevent its most senior and business-critical employees from leaving to start up in competition or join a competitor has been subject to common law rules relating to restraint of trade. The result has tended to be a lack of legal certainty, and lengthy and costly litigation (good news for lawyers; not so much for employers or employees). In December 2020, the UK Government started to consult about potential options for reforming non-compete clauses, in order to reduce litigation and to promote economic growth through greater competition and innovation. That consultation finished in February 2021 and, in May 2023, the Government finally announced its response.
Proposal
In summary, the Government has decided not to implement either of the options proposed in the original consultation, which were: (i) to require businesses to compensate the employee for the duration of the non-compete clause; and (ii) an outright ban on post-termination non-compete clauses. Instead, it has confirmed its intention to introduce legislation “when parliamentary time allows”, which will impose a statutory maximum term of 3 months on non-compete clauses. Under the proposals, there will be no change to other post-termination restrictions, such as non-solicitation, non-dealing and non-poaching clauses, or to garden leave provisions.
Some of the key questions and potential grey areas that will need to be addressed if the legislation is implemented are set out below.
Scope And Application Of The Statutory Limit
The Government’s response states that the statutory 3-month limit will apply to “non-compete clauses ... in contracts of employment and limb (b) worker contracts”. This gives rise to a number of questions.
1. What is a non-compete clause?
Although non-compete clauses are not formally defined in the Government’s response, there is reference to them being:
“clauses ... inserted into employment contracts to restrict an individual’s ability to work for a competing business, or to establish a competing business for a defined period after termination.”
It therefore appears clear that this will include any direct restriction on an individual taking up employment with a competitor of their employer for a prescribed period of time.
However, the response does not address the position where, instead of a direct restriction, an individual is subject to a contractual provision under which they forego (or perhaps even have to pay back) a bonus or other incentive payment if they join a competitor. This could potentially be at least as effective in deterring an individual from moving as a ‘direct’ non-compete yet it is not clear whether the statutory limit will apply to restrictions of this type.
This question is particularly relevant in the context of long term incentive plans (LTIPs) and carried interest arrangements, which often include ‘indirect’ non-compete restrictions of this type. The value of the sums forfeited / repayable under these schemes can be very substantial, and the period for which the restriction applies is often much longer than the maximum period for which a direct non-compete would be enforced. The effect of the statutory limit will therefore be significantly undermined if it does not apply to provisions of this type
2. Does a ‘contract of employment’ include ‘collateral’ agreements, such as long-term incentive plans and carried interest arrangements?
Even if the legislation confirms that indirect non-competes are subject to the statutory limit, there is still a question of whether agreements containing them fall within the scope of an “employment contract”. The original consultation considered whether it would be necessary to reform non-compete provisions in other agreements or other post-termination restrictions in addition to reforming non-compete clauses in employment contracts. The Government’s response acknowledged that not doing so could result in, for example, restrictions being moved to collateral agreements. However, it concluded that the statutory limit should not apply to such ‘wider workplace contracts’ as this could lead to increased litigation about the application of the limit.
It is notable that the Government’s conclusion in relation to ‘wider workplace contracts’ referred to partnership agreements, LLP agreements, and shareholder agreements but did not directly refer to LTIPs or carried interest arrangements. It therefore remains to be seen whether these are captured by the definition of “employment contract” when the legislation is introduced. It is worth highlighting that the High Court has previously found (in Duarte v Black and Decker [2007] EWHC 2720 (QB)) that a separate LTIP agreement imposing post-termination restrictions on an employee should be treated as an “individual employment contract” (in that case, for the purposes of deciding the governing law of the contract). Unless this is addressed explicitly in the implementing legislation, this would appear to give lawyers a good basis to argue that the same approach should be taken in relation to non-competes in LTIPs or carried interest documentation.
Another gap in the response is the failure to address settlement agreements, which commonly include a reiteration or re-casting of post-termination restrictions, including non-competes, in return for separate consideration. It is difficult to see an interpretation of “employment contract” that includes settlement agreements. As such, unless the legislation addresses this anomaly, this may present employers with a backdoor means of circumventing the statutory limit (albeit subject to negotiation and at a cost).
3. What is a “limb (b)” worker?
As above, the Government response confirms that the limit will apply to contracts of employment and limb (b) worker contracts. The reference to ‘limb (b)’ workers is a reference to Section 230(3)(b) of the Employment Rights Act, which defines a “worker” for the purposes of worker rights. The extension of the statutory limit to workers contracts raises a few conflicting points:
It is generally difficult to justify including a non-compete in a worker contract, which is acknowledged in the Government’s response. As such, the specific reference to workers seems somewhat unnecessary and is presumably included simply as a deterrent to employers.
There is authority (Clyde & Co LLP & another v Bates van Winkelhof [2014] UKSC 32) that members of LLPs should be treated as workers (and, although untested, it seems likely that that this would apply to partners in traditional partnerships as well). However, partnership agreement and LLP agreements are among the ‘wider work contracts’ explicitly excluded from the scope of the limit in the Government’s response.
This leads to a rather contrary position where: the statutory limit applies to workers (which should include LLP members and, potentially, partners), even though the Government’s position is that non-compete clauses in worker contracts will generally be unenforceable anyway; but non-compete clauses in LLP agreements will not be subject to the statutory limit. This is particularly significant given the longstanding authority (Bridge v Deacons [1984] 2 All ER 19) under which restrictions imposed on partners are much more likely to be enforced than comparable restrictions in employment contracts.
4. Will the limit be retroactive?
It is not yet clear how (if at all) the limit will apply to restrictions in existing contracts. It is possible that the law will, in effect, replace any non-compete term of more than three months in an existing contract with a 3-month term. However, if the legislation simply renders any term in excess of three months unenforceable, employers will need to renegotiate any non-compete restrictions in excess of three months or lose the protection. Renegotiation is likely to require the payment of additional consideration to the affected employees in order for the restrictions to be enforceable.
If the change is not retrospective, employers may be left in the unsatisfactory situation where they have different restrictions in place for employees doing the same or similar roles and face employees resigning simply to get a new contract with a shorter non-compete. In either event, the net result will be additional uncertainty and costs for employers, and more work for lawyers, at least in the short term.
5. Impact on garden leave provisions
The Government’s response confirms that the reforms will not affect an employer’s ability to use paid notice periods or place employees on garden leave. As such, one option available to employers who want to keep employees out of the market for more than 3 months will be to extend notice periods and place departing employees on garden leave when appropriate.
This would be contrary to the core purpose of the statutory limit, i.e. to promote employee mobility and encourage growth and innovation. It therefore remains to be seen whether the legislation addresses the relationship between long notice periods and non-competes (and if so, how). Employers may also decide that set-off provisions (where time spent on garden leave is offset against the restricted period) are unnecessary in circumstances where the restriction only endures for 3 months. This could result in employees being kept out of the market on long periods of garden leave, followed by an additional non-compete of up to 3 months. Again, this would appear to run counter to the stated intentions of the reform.
Considerations For Employers
It would be premature for employers to make swingeing changes to their employment contracts before the relevant legislation has been introduced. However, there are a number of steps that they could consider taking now.
Thought should be given to re-drafting other post-termination restrictions, such as non-solicitation, non-poaching and non-dealing clauses and confidentiality provisions, to provide greater protection. Employers will be in a stronger position to do this now (perhaps at the same time as salary reviews or bonus awards) than if they wait until the statutory non-compete limit has been introduced.
Employers may also want to consider extending notice periods for certain employees, although clearly this will come at a cost. As noted above, in due course there may also be a case for removing the application of off-set provisions to non-compete clauses. However, it is worth noting in this respect that the 3-month limit will still be subject to the current restraint of trade rules and so even this shorter period may not be enforced if time spent on garden leave is not offset.
Finally, employers in certain sectors may want to consider whether they can protect themselves and achieve the same aims by using ‘indirect’ restrictions linked to the forfeiture or repayment of remuneration and/or “wider workplace contracts’ such as LLP agreements or shareholders’ agreements. These options will not be appropriate for every employer and, as above, it remains to be seen whether these potential loopholes will be closed when the legislation is introduced. However, taking action now is likely to be easier than attempting to do so after the limit has been introduced, when employees will be much more resistant to accepting changes.
